The US Supreme Court has ruled that a five-year statutory limitation period imposed under the US Code (28 U.S.C. §2462) runs from the date of accrual of the claim, and not from the date the cause of action was “discovered” as the SEC had contended. The fraud-based discovery rule does not apply to a Government enforcement action for civil penalties (absent express statutory provision to the contrary).
This very significant decision provides some degree of certainty for participants in the financial markets as it will put a backstop on US Government enforcement actions. Its potential ramifications are however much broader, as the relevant US Code provision has application well beyond securities law – one agency which may be affected is the IRS, since the Supreme Court’s decision now calls into question several rulings of Circuit Courts of Appeal which had concluded that an IRS penalty accrues only once it is assessed.
In 2008, the US Securities and Exchange Commission (SEC) took action for civil penalties against Alpert and Gabelli, alleging that, between 1999 and 2002, they had aided and abetted investment adviser fraud by permitting an investor in the Gabelli Global Growth Fund to engage in market timing of that fund in exchange for the investor’s investment in a hedge fund run by Gabelli.
Under 28 U. S. C. §2462, a five-year statute of limitations applies:
“Except as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.”
This statute of limitations is not specific to the Investment Advisers Act (which covered the underlying offences), or even to securities law; it governs many penalty provisions throughout the U. S. Code.
Gabelli and Alpert argued that because the complaint alleged illegal activity up until August 2002, but was not filed until April 2008, it was time-barred and the civil penalty claim should be dismissed. The District Court agreed, but the Second Circuit reversed that conclusion, accepting the SEC’s argument that the statute of limitations did not begin to run until the SEC discovered or reasonably could have discovered the fraud.
The discovery rule provides an exception to the standard rule that a claim accrues when the plaintiff has ‘a complete and present cause of action’, and it delays accrual of the claim until a plaintiff has ‘discovered’ his cause of action. The discovery rule was developed because it was recognised that cases of fraud, where a defendant’s deceptive conduct can prevent a victim from even knowing that he or she has been defrauded, merited a different approach, provided that there is no fault or want of diligence or care on the part of the victim.
However, the Supreme Court had never applied the discovery rule in the context of a plaintiff who was the Government bringing an enforcement action for civil penalties, rather than a defrauded victim seeking recompense. The Court stressed that in a civil penalty action, the Government is not merely a different kind of plaintiff ; it also seeks a different kind of relief – not compensation for loss or damage, but censure for wrongdoing, and punishment of culpable individuals.
The Supreme Court considered and distinguished cases where the Government was itself a victim of fraud suing to recover its loss. It also highlighted the particular challenges that a court attempting to apply the discovery rule would face in determining when the Government, as opposed to an individual, knew or reasonably should have known of a fraud, and the additional complications that the Government’s assertion of privileges (e.g. law enforcement, attorney-client, work product, or deliberative process) would add.
The Supreme Court considered a number of examples where Congress had made express statutory provision applying a discovery rule in the context of Government suits. These had either coupled the rule with an absolute provision for repose (e.g. a 10 year ultimate backstop), which any judicially imposed discovery rule would lack, or had made provision seeking to identify the official whose knowledge would be relevant.
In this case, the Supreme Court concluded, it had no mandate from Congress to undertake the challenge of applying a discovery rule to Government penalty actions.